Restaurants — hit particularly hard by the economic slowdown — are promoting reduced price menus to drive traffic and reel in struggling consumers. In a similar vein, shopping center owners are finding that if they want to keep restaurants in place, they may need to cut prices too. As a result, operators are offering concessions and higher allotments for tenant improvements to keep restaurant owners in place.

Like retail stores, restaurants have seen spending abate as cash-strapped Americans contend with a global economic crisis that has fueled fears of a continued rise in U.S. unemployment against the backdrop of higher food and energy costs and slumping housing prices. The effect? Some restaurant chains have declared bankruptcy, shuttered locations and reneged on signed leases.

“Most restaurant chains are not expanding, and in some cases, they are contracting,” says Steve Althoff, senior vice president of leasing and property management at Sembler Co., a St. Petersburg, Fla. — based retail developer with its significant footprint in the Southeast.

In the second quarter of 2008, same-store sales for restaurant and food service units were only up by 0.39 percent compared to a 2.00 percent increase in the same quarter for the previous year, according to Technomic, Inc., a food service research and consulting firm based in Chicago. As of October, there had been 13 bankruptcy filings for U.S. restaurant companies and franchisee operators, up from two during all of 2007, according to Boston-based New Generation Research, Inc.'s bankruptcydata.com.

Coinciding with the increased number of restaurant bankruptcies is a precipitous decline in development of retail space. According to McGraw-Hill Construction, during the first seven months of the year development within the restaurant/entertainment sub-class was valued at $692 million, down from $1.3 billion during the same period last year. Restaurant/entertainment construction starts through July amounted to 5.3 million square feet versus 9.9 million square feet in 2007.

Fast and casual

Casual sit-down and fine dining restaurants have been hit the hardest on the sales side, says John Hamburger, president of the Franchise Times Corp., a Minneapolis-based business-to-business publisher. The majority of those that had filed bankruptcy were mid-price and casual dining establishments, including Tampa, Fla.-based Shells Seafood and S&A Restaurants, headquartered in Dallas, a subsidiary of the Metromedia Company, owner of the Steak & Ale and Bennigan's chains.

Even strong brands like the Cheesecake Factory and P.F. Chang's China Bistro have less customer traffic than a year ago because people are cutting back, says John Owens, senior stock analyst who specializes in restaurants at Morningstar in Chicago. According to Technomic, same-store sales for the Cheesecake Factory were down 4.1 percent in the second quarter compared to the same quarter in 2007 and P.F. Chang's same-store sales decreased by 2.3 percent for the same period.

However, fast-food chains are faring better, says Althoff. Technomic reported fast-food sales in the second quarter were up 1.5 percent compared to 2007. Same-store sales at full-service restaurants (the category includes chains ranging from Denny's to Benihana), meanwhile, were down 0.7 percent during the same time frame.

But even in the fast-food industry, the aggregate statistics look better than they would otherwise because of the performance of several strong chains, including McDonald's Inc., whose sales in its U.S. units were up 3.4 percent in the second quarter 2008 over the second quarter in 2007 and Burger King Corp., whose sales at company stores were up 5.5 percent.

One rule of thumb in tracking the downturn in restaurant sales is to follow the trail of U.S. foreclosures, says Joel Bloomer, senior equity analyst at Morningstar in Chicago. He says California and Florida have been hit harder than the Midwest and Northeast. In August alone there were 303,879 foreclosure filings throughout the United States, reports Irvine, Calif.-based Realty Trac. Of those, 101,724 (33 percent) were in California and 44,000 (14 percent) were in Florida.

“I think that a lot of retailers in Central Florida, as well as restaurants, are holding on until the Christmas holiday, but may close after January 1, 2009,” says Jeff Sweeney, managing principal and president at the Orlando office of Grubb & Ellis Commercial Florida. He notes shoppers are still frequenting mall restaurants but check totals are falling.

Digesting the news

Despite the pain in the sector, there are still a handful of chains looking to expand, including Chick-fil-A and Red Robin, Althoff notes. However, landlords do need to weigh an important factor. Would they rather lose the tenant they have and replace it with one of the growing chains if that means downgrading the type of tenant moving in or would they rather offer concessions to keep who they have in place?

“We may turn down a restaurant as a replacement for another if it doesn't have the right price point, or is not financially capable,” says Phoenix-based Greg Cochran, senior vice president of national restaurant leasing for the Santa Monica, Calif.-based Macerich Co. Sweeney says, “If you are replacing a Bennigan's with Billie Bob's Barbecue, you are going from what you thought was an A-credit tenant to a C-credit one, and most shopping center owners are not willing to do that.”

At Miami Beach, Fla.-based brokerage firm Koniver Stern Group, managing director Michael Finkle says retail rents are declining, albeit on a case-by-case basis, and cites the dialogue between the landlord and their tenant.

“Some landlords [in South Florida] are saying to their tenants, ‘We'll reduce the rent now, but next January [during the tourist season] you can pay me the rest,’” he says. While owners of large regional malls are willing to let a space go dark rather than lease to a less lucrative tenant, landlords of smaller centers are more amenable to giving tenants rent relief.

Meanwhile, some landlords, while not officially lowering the rent, are postponing scheduled increases, says Ft. Lauderdale-based Lori Schneider, senior vice president and senior director, of the national retail group at Marcus & Millichap.

Owens noted that a lot of tenants are going back to their landlords to try to renegotiate, as their leases come up for renewal. And, sometimes they try to re-negotiate in the middle of a lease. “Restaurant occupancy costs should be coming down as tenants ask for cheaper rent,” says Owens. West Palm Beach, Fla.-based NAI/Merin Hunter Codman's director of retail sales and leasing Bruce Corn says, it's primarily the local mom-and-pops that are seeking rent relief. “An Applebee's or a P.F. Chang's usually has enough staying power without help from the landlord.”

At its 40,000- to 100,000-square-foot centers, Coral Gables, Fla.-based Investment Management Associates CEO Daniel Baumgard says he is seeing more vacancies today than he has in the past 15 years, which is why he is receptive to lowering rent. That said, in this climate he won't green light a prospective tenant that doesn't have good credit or is poorly capitalized. “No one tells me not to lease for less than $35 per square foot, because I own these centers,” says Baumgard.

Morningstar's Bloomer explains there is a significant distinction between independently owned and operated firms and a publicly traded REITs, which can't be as flexible in setting rents because they have to pay shareholders dividends.

In some cases, notes Merrie Frankel, vice president and senior credit officer at Moody's Investors Service, a privately-held retail chain can be required to show a landlord its financial statements. Scrubbing a tenant's financial statements will not always uncover a red flag that could prompt a tenant's departure or bankruptcy filing. When that happens, a chain is often liable for lease payments, says Frankel. Typically, bankrupt companies have assets to cover their liabilities and a lease is a liability. “There are cases when a bankrupt chain has an outlet in a mall and it's one of the company's best performing restaurants. In these cases, the owner may still ask the tenant to leave, because of the financial vagaries of bankruptcy, she says.